Some Blame Must Follow the Financial Collapse

Posted on Nov 11, 2008

By William Pfaff

PARIS—During a weekend discussion of the world credit crisis by the Trilateral European Group, meeting in Paris, one of a panel of bankers said that the time for recriminations is past: “We all made mistakes, now we must look to the future,” etc. At that, a member who is also a deputy in the French Parliament leaped up and demanded the floor. “What am I going to tell the public when in a few months the French unemployment rate has soared, and there are 3 million people marching in the streets of Paris? That ‘we all made mistakes’? That no one was really responsible?”

The indignation was completely justified. Not only are there guilty men, but many have since compounded their guilt by what they have done with taxpayer money handed over to banks and financial institutions to restore the flow of credit essential to the economy.

In the U.S., some have coolly diverted the money to buy up distressed institutions to aggrandize their own organization, profits and personal perquisites.

In Washington, Federal Reserve Chairman Ben Bernanke and Treasury Secretary Henry Paulson failed to impose conditions on the use of government aid, and only belatedly, under congressional pressure, stipulated that the public should benefit from any eventual profits generated by currently unsalable instruments. Taxpayers should have a share in any turnaround.

When British Prime Minister Gordon Brown introduced his plan to partially nationalize British banks, they were instructed that the money was for business loans to get the economy functioning. The American reluctance to set conditions apparently reflected the assumption that business and financial circles would consider this “socialist” interference with the free markets whose self-inflicted collapse had brought all of this on.

Rigid market ideology is a professional deformation of American bankers and flows through the veins of business itself (hence the furious debate over whether General Motors deserves government rescue from its own managerial incompetence). It also has influenced foreign bankers and business executives who learned their economics according to the doctrines proclaimed by the University of Chicago and Harvard Business School. They went home to attack such heresies as social capitalism and state supervision of finance, so that even Germany today finds some of its banks drowned in the tide of junk financial instruments from America.

The major West European banks that seem to have best survived are Spain’s, where despite protests that this was outrageously reactionary, government insisted that banks build a high designated cash reserve against loans, and in France, where despite Nicolas Sarkozy’s romantic view of America, the traditional centralization and political oversight of financial institutions and corporations spared the country the worst of the crisis.

As others have said, to little avail, the fallacy in modern market economics and hence of contemporary capitalism is the assumption of the perfect rationality of economic actors. They are expected consistently to make good-faith decisions that serve their own interests, which in interaction with others making similar decisions are expected to result in market equilibrium.

As Mark A. Sargent of Villanova University recently wrote in reviewing Charles R. Morris’ book “The Trillion Dollar Meltdown,” a positive result of the deregulation of the 1970s and 1980s was the leveraged buyout of many inefficient companies.

This was followed by the unforeseen contamination of the system by a proliferation of deals lacking any economic rationale other than to produce fees for deal-makers and advisers, leaving companies ruined by debt.

The credit market, fueled by speculation, “started to freeze in October 2007,” with the undermining of trust among institutions, with the result a year later of “an interplay of greed and fear (that) burst the credit bubble.” The result we see today.

The speculative bubble rested essentially on stealing from the poor by persuading them to buy mortgages they couldn’t afford. Those mortgages, merged into a mass of funds of similar anonymous origin, were arbitrarily treated as valid “securities” from which multiple derivative credit instruments could be created.

No one guilty? For one example, read the account by Gretchen Morgenson in the Nov. 10 New York Times of how Merrill Lynch ran its highly lucrative “subprime” mortgage business. It penalized those on its staff who warned of risk and deliberately weakened internal credit controls. When the AIG insurance group (with its own crisis impending) refused to continue to insure the supposedly highest-quality Merrill specialty-product “synthetic collateralized debt obligations” because AIG management was concerned about “overly aggressive home lending,” Merrill coolly continued business with its mortgage bets uninsured.

The man brought in to clear away the wreckage, John Thain, head of the New York Stock Exchange, said no trading business should take risks able “to wipe out an entire year’s earnings,” not to speak of risks able to destroy the earnings of an entire company. In September, of course, Merrill was taken over by Bank of America.

As this crisis works its course of devastation through what bankers once described with disdain as “the real economy,” it is unthinkable that in America and abroad there will not be demands for a legislative or blue-ribbon panel investigation of these practices, and of the business executives who invented or condoned these practices, followed by civil or criminal prosecutions. Not that this will help the people in the streets—either demonstrating or taking up abode there, for lack of any other.